The opportunities for fixed loan investors

loan investors

The introduction of the Euro has reduced the opportunities for Euro fixed income investors to generate an excess return over government bonds, for example, by earning risk premia or adding currency exposure to their portfolios.

Therefore, they have increasingly focused on credit as the primary source of alpha. However, after the massive credit spread tightening in 2003 the potential for outperformance seems rather limited. Including investments in foreign currencies can be a viable way to earn excess returns for corporate bond investors. Yet many portfolio managers are restricted from taking on currency risk, leaving them only with the possibility to exploit inefficiencies in the pricing of credit across currencies. The crucial question then is whether there is a global corporate bond market, that is, whether there is sufficient comovement between the major credit markets that allows to identify mispricings between bonds from one issuer but in various currencies and to benefit from an eventual correction of this inefficiency.

Hence, one has to address the issue of the degree of integration of credit markets, in particular the US, Euro, Sterling and Yen markets. In general the following relationship holds: the more integrated various markets are, the more is their performance determined by common systematic risk factors. Usually, highly integrated markets tend to move together, exhibiting high correlations. Therefore they offer few diversification. In segmented markets, conversely, there is a low degree of comovement across markets. While in this case the benefits of diversification can unfold completely, exploiting differences in credit spreads across markets and currencies is extremely difficult. Even if spread differences between the Libor spreads of bonds from one issuer, denominated in various currencies, are observed, profitable trading strategies require that mispricings will be corrected eventually.